Mergers and Acquisitions-Tax impact and valuation

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Mergers and Acquisitions-Tax impact and valuation

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Mergers and Acquisitions-Tax impact and valuation

  1. 1. Roles of Management Graduates in Mergers and Acquisitions By Prof. Augustin Amaladas M.Com.,AICWA.,PGDFM.,B.Ed . For IMIS Bhubaneshwar 28/04/08 –at 9.20 AM
  2. 2. Issues related to Mergers and Acquisitions. <ul><li>Direct Tax implications </li></ul><ul><li>Sales tax implications </li></ul><ul><li>Foreign Direct investments </li></ul><ul><li>Method of valuation </li></ul><ul><li>Anti Trust Act </li></ul><ul><li>Financing of Mergers and Aquisitions </li></ul><ul><li>Role of Investment Bankers </li></ul><ul><li>Accounting of Mergers. </li></ul>
  3. 3. Recent Mergers and Acquisitions <ul><li>HORIZONTAL MERGER </li></ul><ul><li>As Ford announced the sale of the two British iconic cars to Tata Motors Ltd.for 2.3 billion. </li></ul><ul><li>Ford acquired Jaguar for $2.5 bn in 1989 and Land Rover for $2.75 bn in 2000 but put them on the market last year after posting losses of $12.6 bn in 2006 - the heaviest in its 103-year history. </li></ul>
  4. 4. The Hutch and Vodafone merger <ul><li>Hutchison Essor </li></ul><ul><li>Indian Company </li></ul>Vodafone(Briton) A Foreign company HTIL( Whampoa group of Li-Ka Shing. Hong Kong A foreign company 67% Takes over Asim Ghosh-12% A.Singh and other companies (Minority) Essor group
  5. 5. INCOME TAX RELATED ISSUES FOR AMALGAMATION <ul><li>CONDITIONS OF AMALGAMATION UNDER INCOME TAX ACT SEC 2 (1B) </li></ul><ul><li>ALL ASSETS AND LIABILITIES OF TRANSFEROR CO. TO BE THE ASSETS OF THE TRANSFREE CO. </li></ul><ul><li>SHARE HOLDERS HOLDING NOT LESS THAN 3/4 TH IN VALUE OF SHARES OTHER THAN SHARES ALREADY HELD SHOULD BECOME SHARE HOLDERS OF AMALGAMATED COMPANY </li></ul><ul><li>EX. NO. OF SHARES OF Altd CO. 1,00,000 </li></ul><ul><li>NO. OF SHARES HELD BY Bltd IN Altd IS 20,000 </li></ul><ul><li>NOMINAL VALUE OF SHARE IS RS.10 </li></ul><ul><li>ASSUME Altd MERGE WITH Bltd THEN 75% OF 1,00,000- 20,000 = 60,000 TO BE THE SHARE HOLDES OF B CO. </li></ul><ul><li>NOTE:SHARE HOLDERS MAY BE EQUITY OR PREFERNCE SHARE HOLDERS </li></ul>
  6. 6. OTHER CONDITIONS <ul><li>THE AMALGAMATED CO. IS AN INDIAN CO. </li></ul><ul><li>EXCEPTION </li></ul><ul><li>IF SHARES OF INDIAN CO.HELD BY FOREIGN BEFORE MERGER AND SUCH FOREIGN CO. TAKEN OVER BY ANOTHER FOREIGN CO. </li></ul><ul><li>ATLEAST 25% OF THE FOREIGN CO. (BEFORE MERGER) TO BE SHARE HOLDERS OF THE NEW FOREIGN CO. </li></ul><ul><li>? WHAT IS THE BENEFIT TO THE AMALGAMATED CO. AMALGAMATING CO.(OLD CO.) </li></ul>
  7. 7. <ul><li>NO CAPITAL GAIN ON TRANSFER ON CAPITAL ASSETS BY THE TRANSFEROR CO. UNDER SEC 47(VI) OF I.T ACT </li></ul><ul><li>? CAN NEW CO. CARRY FORWAD AND SET OF LOSS AND DEPRECIATION </li></ul><ul><li>SEC 72 A TO BE FULFILLED </li></ul><ul><li>ACCUMULATED LOSSES REMAIN UNABSORBED FOR 3 OR MORE YEARS </li></ul><ul><li>75% OF BOOK VALUE TO BE HELD ATLEAST FOR 2 YEARS BEFORE AMALGAMATION </li></ul><ul><li>THE AMALGAMATED CO. CONTINUES TO HOLD 3/4 TH OF BOOK VALUE ATLEAST FOR 5 YEARS </li></ul><ul><li>NEW CO. SHOULD CONTINUE FOR ANOTHER 5 YEARS </li></ul><ul><li>NEW CO. SHOULD ACHIEVE ATLEAST 50%OF INSTALLED CAPACITY BEFORE END OF 5 YEARS AND SHOULD CONTINUE FOR 5 YEARS </li></ul>
  8. 8. <ul><li>A LTD AMALGAMATES WITH B LTD AS ON 1 st April 2008 </li></ul>NO CAPITAL GAIN TAX & ACCUMULATED LOSSES & UNABSORBED DEPERICIATION CAN BE CARRIED FORWARD DOES NOT ATTRACT CAPITAL GAIN FOR A BUT NO GAIN FOR B NO BENEFIT TO A & B A MERGES WITH B (A GOES OUT) SATISFIES BOTH 2(1B) & 72 A SATISFIES 2(1B) BUT DOES NOT SATISFY 72 A DOES NOT SATISFY SEC 2(1B) & 72 A PARTICULARS
  9. 9. <ul><li>? If B merges with A . If B goes out of market who gains under above 3 situations </li></ul><ul><li>? If A&B merge with c. what are the tax implication under above situations? </li></ul><ul><li>. Assume B is a loss making co. Can accumulated losses & unabsorbed depreciations be carried forward and set off by the new company? </li></ul><ul><li>? If C is not an Indian co? </li></ul>
  10. 10. Tax Concession To Share Holders Of Amalgamating Co. <ul><li>No capital gain tax provided, new co. is an Indian co.& Shareholders are acquired everything in shares </li></ul>
  11. 11. EXERCISE 40 70 MARKET PRICE 8 10 P/E RATIO 5 7 EPS 7,500 20,000 NO. OF SHARES 37,500 1,40,000 EAT CO. B CO. A PARTICULARS
  12. 12. <ul><li>Co. A is acquiring co. B. Exchanging one share for every 1.5 shares of B Ltd & P/E ratio will continue even after merger </li></ul><ul><li>? Are they better or worse of than they were before in merger </li></ul><ul><li>?? A is an Indian co. </li></ul><ul><li>? A is a foreign co. </li></ul><ul><li>? A merges with T & formed a new co. AT ltd </li></ul><ul><li>? What are the tax planning required before & after merger </li></ul>
  13. 13. CONCLUSIONS <ul><li>EXCHANGE AT EPS – NO EFFECT ON EPS AFTER MERGER </li></ul><ul><li>EXCHANGE MORE THAN EPS RATIO – COMPANY WITH LOWER EPS GAINS </li></ul><ul><li>IF LESS THAN EPS RATIO – COMPANY WITH HIGHER EPS BEFORE MERGER GAINS </li></ul>
  14. 14. CONCLUSION <ul><li>IF SHARES ARE EXCHANGED BASED ON CURRENT MARKET PRICE PER SHARE , POST MARKET PRICE SHARE INCREASED AT HIGHER RATE THAN EXCHANGED BELOW THIS RATIO </li></ul><ul><li>Boot strap effect </li></ul>
  15. 15. CONCLUSION <ul><li>FIRM WITH HIGHER P/E RATIO CAN ACQUIRE FIRM WITH LOWER P/E RATIO WHICH WILL INVARIABLY INCREASES MARKET VALUE AFTER MERGER </li></ul>
  16. 16. Conclusion <ul><li>Fulfill section 2(1B) of Income tax act by transferor company </li></ul><ul><li>Amount to be in the form of shares </li></ul><ul><li>No cash to be received </li></ul><ul><li>Foreign Direct investments in selected sector can not exceed 74% by foreign company </li></ul><ul><li>Fulfill section 72A of the IT act so as to reap the benefit by transferee company </li></ul><ul><li>Shareholders can not transfer their holdings with in 5 years. </li></ul><ul><li>Sales tax at the rate of 8% can not be avoided. </li></ul><ul><li>Set off and carry forward of losses is possible. </li></ul><ul><li>What are the losses can be carried forward and set off? How many years? </li></ul>
  17. 17. Some Facts-USA Companies <ul><li>1897-1904-horizontal Mergers </li></ul><ul><li>Monopolistic Market structure </li></ul><ul><li>Mega merger between US Steel and Carnegie Steel.It also merged with 785 separate firms-75% of Steel production of US. </li></ul><ul><li>As a result: ???? What happened to Standard Oil? </li></ul>
  18. 18. Standard Oil(SO) <ul><li>Broken in to 30 Companies. Some of them are </li></ul><ul><li>SO of New Jersey named EXXON </li></ul><ul><li>SO of New York named MOBIL </li></ul><ul><li>SO of California renamed CHEVRON </li></ul><ul><li>SO of Indiana renamed AMOCO </li></ul><ul><li>What is ANTI TRUST Act? What is known in India? </li></ul><ul><li>HCL was formed? </li></ul>
  19. 19. HCL <ul><li>Hindustan Computers, Hindustan Reprographic, Hindustan Telecommunications and Indian Software Ltd. </li></ul>
  20. 20. <ul><li>In February 2008, as many as 38 cross-border deals were announced with total value of $2.80 billion, of which 27 were outbound deals with a value of $2.57 billion </li></ul><ul><li>.In March 2008 it has crossed $10 billion in investment by Indian Companies outside India. </li></ul>
  21. 21. Diologic <ul><li>Meanwhile, global financial information provider Diologic in its latest report said that India-targeted M&A volumes reached $11.9 billion through 345 deals so far this year. US was the leading acquiring country with deals worth 1.6 billion dollars, followed by the UK with $904 million and Germany with USD 584 million. </li></ul>
  22. 22. Some Facts <ul><li>Between 1926 and 1930- there were 4600 mergers took place </li></ul><ul><li>Result of which between 1919 and 1930 12,000 companies went out of market. </li></ul><ul><li>The second wave came to an end when stock market crashed on October 29,1929. </li></ul><ul><li>Investment Bankers played in the first two phases of mergers. </li></ul>
  23. 23. 1965-69 in USA <ul><li>Management principles were applied in industries. </li></ul><ul><li>Management graduates were employed to manage conglomerate mergers. </li></ul><ul><li>There were 6000 mergers which leads to 25000 firms disappeared. </li></ul><ul><li>Investment Bankers do not finance most of these mergers </li></ul><ul><li>Finance:-???? </li></ul>
  24. 24. <ul><li>Equity financing </li></ul>
  25. 25. EXERCISE <ul><li>COMPANY A </li></ul><ul><li>NO. OF SHARES 2 LACS </li></ul><ul><li>MARKET VALUE PER SHARE RS.25 </li></ul><ul><li>EPS RS.3.125 </li></ul><ul><li>COMPANY B </li></ul><ul><li>NO. OF SHARES 1 LAC </li></ul><ul><li>MARKET VALUE RS.18.75 </li></ul><ul><li>EPS RS.2.5 </li></ul>
  26. 26. PRICE EARNING RATIO APPROACH <ul><li>MEANING </li></ul><ul><li>COMPUTATION : </li></ul><ul><li>P/E RATIO = MP/EPS </li></ul><ul><li>EPS = EAT/NO. OF EQUITY SHARES </li></ul><ul><li>MARKET PRICE = P/E (NO. OF TIMES) * EPS </li></ul>
  27. 27. EXAMPLE 7.5 8 P/E RATIO(TIMES) 18,75,000 50,00,000 TOTAL MARKET VALUE (N*MPS) OR (EAT*P/E RATIO) 18.75 25 MARKET PRICE PER SHARE(MPS) 2.5 3.125 EPS 1,00,000 2,00,000 NO. OF SHARES 2,50,000 6,25,000 EAT FIRM B FIRM A PRE MERGER SITUATION
  28. 28. CONCLUSION <ul><li>IF SHARES ARE EXCHANGED BASED ON CURRENT MARKET PRICE PER SHARE , POST MARKET PRICE SHARE INCREASED AT HIGHER RATE THAN EXCHANGED BELOW THIS RATIO </li></ul><ul><li>Boot strap effect </li></ul>
  29. 29. <ul><li>MARKET VALUE AFTER MERGER = MARKET VALUE BEFORE MERGER = 68,75,000 </li></ul><ul><li>NET GAIN = 15,00,000 </li></ul><ul><li>? IF EXCHANGE RATIO IS 2.5:1 WHO GAINS WHO LOSES </li></ul><ul><li>? IF EXCHANGE RATIO IS 1:1 WHO GAINS WHO LOSES </li></ul><ul><li>? HOW TO CALCULATE TOLERABLE SHARE EXCHANGE RATIO </li></ul>
  30. 30. DETERMINATION OF TOLERABLE SHARE EXCHANGE RATIO 75,00,000 10,00,000 TOTAL MV LESS: MINIMUM TO BE GIVEN TO B 1,00,000 NO. OF SHARES OF A TO A CO. SHARE HOLDERS 65,00,000 NET BENEFIT TO A 10,00,000/65 = 15,385 SHARES NO. OF EQUTY SHARES TO BE ISSUED BASED ON DESIRED MARKET PRICE 50,000/15385 = 3.25 SHARES OF FIRM B, 1 SHARE IN FIRM A 1:3.25 TOLERANCE SHARE EXCHANGE RATIO 65 PER SHARE DESIRED POST MERGER MPS
  31. 31. CONCLUSION <ul><li>FIRM WITH HIGHER P/E RATIO CAN ACQUIRE FIRM WITH LOWER P/E RATIO WHICH WILL INVARIABLY INCREASES MARKET VALUE AFTER MERGER </li></ul>
  32. 32. 7.5 8 P/E RATIO (ASSUMED TO BE THE SAME) 21.825 3.125*8=25 MPS 65,47,500 70,00,000 TOTAL MARKET VALUE 8,75,000/3,00,000=2.91/ 8.75/2.8=3.125 EPS 2,00,000+1,00,000=3,00,000 2.8 lakhs NO. OF SHARES 8,75,000 6.25+2.5=8.75 EAT(COMBINED FIRM) 1 : 1 2.5:3.125=.8 EXCHANE RATIO/ SWAP RATIO (ASSUMING) SITUATION 2 SITUATION 1 (BASED ON CURRENT MARKET PRICE POST MERGER
  33. 33. ACCOUNTING FOR AMALGAMATION <ul><li>POOLING INTEREST METHOD </li></ul><ul><li>CONDITIONS AS PER AS 14: </li></ul><ul><li>ALL ASSETS AND LIABILITIES OF TRANSFEROR CO. TO BE THE ASSETS OF THE TRANSFREE CO. </li></ul><ul><li>AT LEAST 90% OF F.V OF EQUITY SHARE HOLDERS SHOULD BE SHAREHOLDERS OF NEW CO. </li></ul><ul><li>PURCHACE CONSIDERATION TO BE SETTLED BY THE NEW CO. </li></ul><ul><li>THE BUSINESS OF NEW CO. SHOULD CONTINUE </li></ul><ul><li>NO ADJUSTMENT IS INTENDED TO BE MADE TO BOOK VALUE OF ASSETS AND LIABILITIES OF TRANSFEROR CO. </li></ul>
  34. 34. Life Education <ul><li>Abraham Lincolin </li></ul>
  35. 35. Thank You All.
  36. 36. Pricing of Capital issues <ul><li>Step-I </li></ul><ul><li>Total assets </li></ul><ul><li>Less: Preference Capital </li></ul><ul><li>Secured and unsecured borrowings </li></ul><ul><ul><ul><li>Current liabilities </li></ul></ul></ul><ul><ul><ul><li>Contingent liabilities </li></ul></ul></ul><ul><ul><ul><li>--------------------------------------------------- </li></ul></ul></ul><ul><ul><ul><li>A.Net Worth </li></ul></ul></ul><ul><ul><ul><li>--------------------------------------------------- </li></ul></ul></ul>
  37. 37. Method II(Liability Approach) <ul><li>Equity Share capital </li></ul><ul><li>Add: Free reserves </li></ul><ul><li>------------------------------- </li></ul><ul><li>Less:- </li></ul><ul><li>Contingent Liabilities </li></ul><ul><li>--------------------------------------------- </li></ul><ul><li>Net worth </li></ul><ul><li>-------------------------------------------- </li></ul>
  38. 38. 2.Profit Earning Capacity Value-PECV <ul><li>Weighted Adjusted Average Profit before Tax </li></ul><ul><li>Less: Provision for Tax at % </li></ul><ul><li>------------------------------------------------ </li></ul><ul><li>Weighted average profit after Tax </li></ul><ul><li>Less : Preference dividend </li></ul><ul><li>---------------------------------------------- </li></ul><ul><li>Net profit after Tax and dividend </li></ul><ul><li>Number of Equity shares including Fresh and bonus shares </li></ul><ul><li>------------------------------------------------------------------------- </li></ul><ul><li>EPS </li></ul><ul><li>PECV= Capitalisation of Profit at 15%/12%/10%/8% respectively </li></ul><ul><li>= Net Profit After tax and dividend*100/15 </li></ul>
  39. 39. 3.Fair value <ul><li>(Net Asset value +Profit Earning Capacity Value)/2 </li></ul>
  40. 40. 4.Average Market Price <ul><li>Year I High Low Average </li></ul><ul><li>Year II </li></ul><ul><li>Year (Current Year) </li></ul><ul><li>4. Monthwise: 1 </li></ul><ul><ul><ul><ul><ul><li>2 </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>3 </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>4 etc for 12 months </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>(Average market price for the three years) </li></ul></ul></ul></ul></ul>
  41. 41. 5. Capitalisation rate <ul><li>If MV not more than 20% of FV-15% </li></ul><ul><li>If MV more than 20%-50% -12% </li></ul><ul><li>Between 51-75 - 10% </li></ul><ul><li>Above 75% - 8% </li></ul>
  42. 42. PE- Multiple <ul><li>Average P/E ratio of related companies are </li></ul><ul><li>Considered to discount </li></ul>

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